In order to contribute to an individual retirement account (IRA), you must have earned income, right?
Although that’s true for most people, the IRS makes an exception for nonworking spouses. The government acknowledges that in some households, one spouse stays home with the kids while the other generates income, so they allow both spouses to contribute to IRAs based on the joint household income. To do otherwise would put these households at an unfair disadvantage in retirement planning.
Known informally as spousal IRAs, these tax-sheltered accounts help families save more money for retirement without the burden of taxes.
Eligibility for Spousal IRAs
The “spousal IRA” is just a regular IRA — the name merely refers to the fact that the working spouse can make a contribution to an IRA held in the name of a nonworking spouse. All the same rules apply, and the stay-at-home parent opens a standard IRA in their own name.
The eligibility requirements for the spousal IRA are straightforward:
- Marital Status: Married
- Tax Filing Status: Married, filing jointly
- Earnings: The contributing spouse must have compensation or earned income of at least the amount annually contributed to the nonworking spouse’s IRA. If the contributing spouse also has an IRA, annual compensation or earned income must exceed the combined contributions of both IRAs.
- Age: The nonworking spouse must be under age 72 in the year of the contribution for a traditional IRA. There are no age restrictions on a Roth IRA for a nonworking spouse.
Understand that IRAs are owned separately, not jointly. This means the nonworking spouse owns the assets in the IRA. Once your working spouse contributes to the IRA, the money becomes yours. The IRA is in your name and opened with your Social Security number, and it remains yours even if you divorce.
How It Works: Creating and Contributing to Accounts
Once you determine that you meet the eligibility requirements, you can open an IRA through your regular investment brokerage (E*Trade and SoFi are our favorites). You open the account in your name even if your working spouse is the one who contributes to it.
Once created, you or your spouse can transfer money into your spousal IRA from your checking account. At the time of transfer, you specify which year you want the contribution to count toward.
You can then invest in any assets allowed by your brokerage. You completely own and control the account, as with all IRAs.
Contribution Limits and Deadlines
Because spousal IRAs work just like any other IRA, the contribution limits are the same. They remain unchanged from 2020 to 2021 at $6,000 per year per adult. Adults 50 and over can contribute an extra $1,000 as a catch-up contribution, for a total annual contribution limit of $7,000.
Thus, a married couple under age 50 can contribute a total of $12,000, and couples over 50 can contribute up to $14,000 per year.
You can contribute to a traditional IRA, Roth IRA, or both. The combined total can’t exceed the limit, so for example a 40-year-old could contribute $2,000 to their traditional IRA and $4,000 to their Roth IRA to max out their annual contributions at a combined total of $6,000.
The IRS allows you to contribute funds to your IRA up until the tax return filing deadline for the previous year — usually April 15, but extended to May 17, 2021, for individuals for tax year 2020. So for the first several months each year, you can make IRA contributions for either the previous year or the current one.
Income Limits and Tax Benefits
Spousal IRAs offer the same tax benefits as an account in the name of a working spouse. These tax advantages come with limits that depend on your age and income, as well as the type of IRA.
The main tax benefit of traditional IRAs is that you can deduct the contribution from your taxable income. You don’t pay taxes on the earnings until you withdraw money from the account during retirement. At that point, the amount you withdraw each year is taxed as regular income. In fact, you must start taking required minimum distributions (RMDs) once you turn 72.
No matter how high your income, you can contribute to a traditional IRA. But you only get the tax benefit of deducting your contribution if the working spouse earns less than the income limits.
If the working spouse doesn’t participate in an employer-sponsored retirement plan, such as a 401(k) or SIMPLE IRA, the deductible amount phases out for incomes between $198,000 and $208,000 in tax year 2021 (up from $196,000 and $206,000 for 2020).
If the working spouse does participate in an employer-sponsored retirement account, the income limits are lower. In 2021, the ability to deduct contributions phases out between $105,000 to $125,000 (up from $104,000 to $124,000 in 2020).
When you contribute to a Roth IRA, you don’t get an immediate tax deduction. Instead, your Roth IRA contributions grow and compound tax-free, and you don’t pay taxes on withdrawals in retirement.
Unlike a traditional IRA, which requires you to begin taking minimum distributions at age 72, you are never required to take minimum distributions from a Roth IRA.
The ability to contribute to a Roth IRA starts phasing out for couples earning more than $198,000 in 2021 ($196,000 in 2020), and disappears entirely for those earning more than $208,000 ($206,000 in 2020).
What Happens to IRAs When One Spouse Dies?
When you open an IRA, you name a beneficiary for the event of your death. The IRA bypasses probate and goes directly to that beneficiary, and creditors can’t touch it. If that beneficiary dies before you do, then your IRA goes into probate to be distributed as part of your estate.
Most married couples name their spouse as the designated beneficiary for their IRA. Spouses get special treatment by the IRS, with more options available to them for handling the inherited IRA.
When you inherit your spouse’s IRA, you can do any of the following with the funds.
Roll Over Funds to Your Own IRA
Unique to married couples, you can roll over funds from your deceased spouse’s IRA to your own IRA. You pay no penalties or taxes on the money at the time of rollover. The funds simply get treated as part of your own IRA from then on.
This is usually the best option for spouses from a tax planning perspective.
Leave the Money as an Inherited IRA
Inherited IRAs follow slightly different rules.
Withdrawals continue to be treated based on your deceased spouse’s age. On the plus side, you can start taking withdrawals penalty-free, even if you’re under 59 ½, as long as your deceased spouse had been over 59 ½. The downside is that you must take required minimum distributions based on your spouse’s age, even if you are under 72.
You can, however, submit a new schedule based on your age.
If you inherit a Roth IRA, you must take RMDs on it, which is not the case with your own Roth IRA (including if you had rolled over the IRA funds to your Roth IRA).
Take All the Money Now
You can just cash out the money in your deceased spouse’s IRA. The IRS doesn’t hit you with penalties, even if you’re under 59 ½. But you do have to pay income taxes on it, which may thrust you into a higher tax bracket.
Disclaim Some or All of the Money
Don’t want the money for some reason?
If you want some or all of the IRA funds to go to your spouse’s other designated beneficiaries instead of you, you can disclaim it within nine months of your spouse’s death. In effect, you take a pass on receiving it, so it goes to the other beneficiaries instead.
This may make sense from a tax planning perspective. Or maybe you just don’t need the money, and the other beneficiaries do.
A spousal IRA is a great way to boost household retirement savings contributions and build a bigger nest egg. Plus, it gives a nonworking spouse the chance to build up assets, rather than missing out on some of his or her potential earning power due to helping out at home. Given the retirement challenges many women face in particular, spousal IRAs can create added financial security in addition to the tax benefits.
If you or your spouse stay at home, check to see if you meet the criteria for eligibility, and consider investing through a spousal IRA.